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Chapter 8

Q. 8.ST.4

Assume that the Canadian dollar’s spot rate is $.85 and that the Canadian and U.S. inflation rates are similar. Then assume that Canada experiences 4 percent inflation, while the United States experiences 3 percent inflation. According to PPP, what will be the new value of the Canadian dollar after it adjusts to the inflationary changes? (You may use the approximate formula to answer this question.)

Step-by-Step

Verified Solution

e_{f}=I_{b}-I_{f}

= 3% – 4%
= -.01, or -1%

S_{t+1}=S(1+e_{f})

= $.85 [ 1 + ( -.01 ) ]
= $.8415